Company Information

Number of outstanding shares = 5,000,000 Free Cash Flow (FCF) = $24,000,000 Expected growth rate = 5%

Short-term investments =$100,000,000 Debt =$200,000,000 Preferred Stock=$50,000,000 WACC =11%

Answer the following questions:

Use a pie chart to illustrate the sources that comprise a hypothetical companys total value. Using another pie chart, show the claims on a companys value. How is equity a residual claim?

Suppose the free cash flow at Time 1 is expected to grow at a constant rate of g_L forever. If g_L < WACC, what is a formula for the present value of expected free cash flows when discounted at the WACC? If the most recent free cash flow is expected to grow at a constant rate of g_L forever (and g_l < WACC), what is a formula for the present value of expected free cash flows when discounted at the WACC?

Use B&Ms data and the free cash flow valuation model to answer the following questions.

What is the estimated value of operations?

What is its estimated total corporate value? (This is the entity value.)

What is the estimated intrinsic value of equity?

What is its estimated intrinsic stock price per share?

You have just learned that B&M has undertaken a major expansion that will change its expected free cash flows to -$10 million in 1 year, $20 million in 2 years, and $35 million in 3 years. After 3 years, free cash flow will grow at a rate of 5%. No new debt or preferred stock was added; the investment was financed by equity from the owners. Assume the WACC is unchanged at 11% and that there are still 10 million shares of stock outstanding.

What is the companys horizon value (value of operations at yr 3)? What is its current value of operations (at time 0)?

What is its estimated intrinsic value of equity on a price-per-share basis?

If B&M undertakes the expansion, what percent of B&Ms value of operations at year 0 is due to cash flows from year 4 & beyond?

Bassed on your answer to the previous question, what are two reasons why managers often emphasize short-term earnings?